In the gathering dusk of Christmas Eve 2009, long after the closure of the healthcare debate, long after the US Senate has closed its doors, long after the US President has departed for his vacation in Hawaii, long after the US Press has shut down its political surveillance for the upcoming festivities, a misleadingly innocent-looking figure flits furtively through the darkened rooms of 1500 Pennsylvania Avenue, NW. A computer whirrs into action as Treasury Secretary Timothy Geithner, fortified by the knowledge that he is entirely alone in the building, presses the Send button of his computer to despatch a carefully-timed Press Release to a hopefully slumbering media. His task well-executed, Secretary Geithner shuts down his office, turns out the lights, and slips quietly into the enveloping darkness of a largely diverted metropolis…
Stirred into action by the curiousness of this event, Sherlock Holmes and Dr. Watson decide to investigate the strange case of A Scandal at 1500 Pennsylvania Avenue, NW. “Let us start with deductions, my dear Watson”, murmers Holmes, as he quickly inserts and withdraws the needle of his syringe into one of his veins. “From these deductions, we can locate the relevant facts and solve this mystery.”
“Now why would the Secretary of the Treasury, a man appointed into office with a mandate from his President to bring a new transparency to the US government, engage in such behavior in the darkness of a festive night?” Holmes inquires of his loyal associate. “Well Holmes, perhaps Secretary Geithner was so obsessed with the important events of the day that he had simply overlooked this message” responds the cognitively more-limited, but well-meaning doctor. “Not so, Watson”, Holmes laconically responds. “Secretary Geithner does not appear to me to be a man who would ever forget his mission to indulge in the unbearably boring trivia of a Senate session. Watson, mischief is afoot in the District of Columbia! Let me advance the hypothesis that a message sent out under such circumstances is designed to be unseen, while yet satisfying a facade of transparency. “
On the basis of this supposition, Holmes quickly assembles the facts relevant to his case. The facts lead Holmes inexorably to a determination that this indeed is a case of government by stealth, a determined attempt by a desperate public servant to outwit a public rendered largely witless by seasonal exuberances. On a dark and stormy night, this is how the story ran…
Government-sponsored enterprises (GSEs as they are called in the Washington dialect) are a group of financial services corporations created by the United States Congress. Their function, in principle, is to enhance the flow of credit to targeted sectors of the economy and to make those segments of the capital market more efficient and transparent. Of course, as with almost everything involving government, the reality is almost exactly the opposite. GSEs are designed to divert funding opaquely and inefficiently to constituents courted politically by members of the Congress and/or by the President. Nowhere is this divergence between principle and reality more marked than with regard to the behavior of the Federal National Mortgage Corporation (FNMA or Fannie Mae) and of the Federal Home Loan Mortgage Corporation (FMLMC or Freddie Mac) in expanding the secondary market in mortgages throughout the United States.
The residential mortgage borrowing segment is by far the largest of the borrowing segments in which the GSEs operate. Currently GSEs hold or pool approximately $5 trillion of mortgages. Of course, if marked to market, this official book value would shrivel to a tiny fraction of that estimate, because much of the portfolio is composed of highly toxic assets. Because the US mortgage market had slowly unravelled over the prior two years, on September 8, 2008, the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac under its conservancy. The enterprises were insolvent and would be propped up by Henry Paulson’s Treasury Department which acquired billions of dollars of their preferred stock, paying at a rate of 10 per cent per annum. The total ‘investment’ was expected to rise to some $100 billion.
The facts unravelled by Sherlock Holmes are as follows: The insolvency of Fannie Mae and Freddy Mac has worsened sharply through the fall of 2009 and will worsen still further once the current program of Federal sub-prime mortgage provisions expires early in 2010. At that time, the market will openly recognize losses of hundreds of billions of dollars in the GSE mortgage pools, where the face values of the mortgages hugely exceed property market values or foreclosure amounts. Secretary Geithner clandestinely is trying to set the scene for full nationalization of the GSEs and for a full specific guarantee of the GSE debt by the US Treasury.
Geithner’s nocturnal machinations set the scene for placing official GSE debt on the US government’s sovereign debt balance sheet. Actually, that is exactly where it belongs, since this has been a game of deception over an implied guarantee and it is more than time for that to stop. Foreign sources and domestic US institutions see through the deception and are loathe to buy GSE debt. In consequence, the Fed has had to step in with over $1 trillion to bolster the US housing market. In so doing, it has downgraded its own balance sheet no doubt to a Baaa3 rating if any of the rating agencies had the nerve to call the Fed’s bluff.
Secretary Geithner is a truly desperate man. Had he not acted in the dead of night, and had the markets responded by pricing GSE debt at wide spreads to Treasury debt, the home mortgage interest rate in the United States would have increased significantly, the nascent housing recovery would have been choked off, and the House of Representatives assuredly would have fallen into Republican hands in 2010. Undoubtedly, Secretary Geithner was acting upon the highest authority to preserve and protect, not his country, but the administration that he currently serves.
Mystery solved. “Elementary, my dear Watson!”